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Is California lounging on the legal cannabis industry?

The bloom is off the bud in California. The much-touted retail cannabis industry, once buoyed by good intentions and high expectations, has turned out to be a great green goose that can’t quite squeeze out the golden egg. Recent data and media reports indicate the state’s for-profit cannabis industry is struggling, hampered by burdensome bureaucracy, excessive taxation, illegal competition and drought. . 

At the end of February, the California Department of Tax and Fee Administration (CDTFA) reported that 2022 tax revenue from adult-use cannabis totaled $1.1 billion, following the third consecutive quarterly decline and a 12% drop year-over-year. Since the debut of retail in 2018, the state has collected $4.6 billion in tax revenue, including $2.3 billion in excise tax and $1.8 billion in sales tax. Not too shabby, but the numbers leave pundits and players wondering how much more revenue could have been collected if the industry wasn’t constrained by onerous regulatory and economic limitations? 

Two legislators feel the industry’s pain. California Assembly members Matt Haney (D-San Francisco) and Ash Karla (D-San Jose) have acknowledged the need for legislative action in hopes of bolstering beleaguered cannabis businesses and have proposed Assembly Bills 374 and 471, respectively. 

AB 374 would loosen regulations on cannabis lounges and allow vendors to sell food and nonalcoholic beverages, as well as charge for live entertainment and events. 

AB 471 would allow cannabis catering by licensed vendors at permitted special events.

Insiders that commented to MJBI all were hopeful the legislation would be approved, though getting cannabis-related bills and regulatory reforms passed and implemented has never been a speedy process.

“I think that California can pull it off,” said Kim Stuck, founder and CEO of Allay Consulting, a firm that advises on compliance strategy for hemp, cannabis and psychedelics businesses. “I mean, there’s a lot more outdoor space that is usable. There’s a lot more tourism there. I think they could really pull it off and have some really good flagship facilities that are actually successful eventually and kind of show the rest of the United States how it’s done, you know?”

But she added that any investors interested in operating a retail cannabis business in California (or elsewhere) should be prepared for complicated regulations and considerable expense, especially if they envision an Amsterdam-style cannabis coffee shop that can serve a latte alongside a bong hit or pre-roll. Stuck commented that regulations for ventilation for an indoor consumption facility typically require a specialized HVAC system that could cost in the tens of thousands – and that’s just for starters. 

“When applying for these licenses, you need to think about the fact that you also have to abide by other rules and regulations, not just the social consumption rules and regulations. I think that sometimes surprises people; they’re a little like, ‘Oh wait, I have to think about building code and the health department and all of these different additions?’ That’s where we run into issues and people get caught up in the red tape. The actual consumption lounge regulations seem like, this would work, we could do this – but then you look at the whole picture, it’s very, very different,” Stuck explained. 

“A lot of times there’s loopholes in regulations in other departments that prevent these social consumption lounges from happening. In fact, in Denver they wanted social consumption lounges in the beginning, but they wrote the regulations so strictly that nobody could even open one up for a very long time until those regulations got changed,” she said.

In West Hollywood, where the city government has enthusiastically welcomed retail cannabis sales, there are more than a dozen dispensaries within the city’s limits, but only two operating consumption lounges – The Artist Tree and the Woods. 

Currently, West Hollywood lounges are allowed to accommodate food consumption, but only food provided by a third-party vendor. The Artist Tree partners with a local restaurant to provide a full menu for guests. The Woods is located next door to vegan restaurant Norah, providing easy access for lounge guests that also want food or drinks.

“We’d like to see the legislation get passed,” The Woods partners Jay Handal and Devon Wheeler said in an email. “Providing our customers with non-infused food and beverages during their stay would be invaluable. We don’t want someone to miss out on experiencing our lounge just because they aren’t into cannabis. This is a space for everyone and the legislation will make it a more inclusive environment that everyone can enjoy. We don’t want to limit the space to only cannabis connoisseurs or the occasional dabbler. There needs to be something for everyone.”

The dispensary lounge, which celebrity co-owner Woody Harrelson plugged when he hosted Saturday Night Live on February 25th, was opened in May 2022. 

The storefront retail area offers specialty strains, concentrates, edibles and CBD products that can be purchased and, if the guest prefers,consumed in the lounge. The outdoor consumption area, called the Ganja Giggle Garden, is located in the rear of the dispensary and offers a lush tropical setting with a Koi pond and antique Buddhist statuary. Ventilated, climate-controlled guest cabanas are available to rent by the hour. Daily, weekly, and monthly locker rentals are available for regulars and guests who want to stash their cannabis. The Woods is a vision of luxurious cannabis hospitality; Handal and Wheeler agree that it’s a continuing process to create a compliant, commercially-viable version of what an upscale cannabis consumption facility could look like. 

“Let me put it this way, it ain’t easy,” Wheeler said. “Between juggling ever-changing regulations to keeping up with fast-paced changes in the industry, it definitely takes perseverance and an unwavering commitment to see things through. There isn’t really a template for what we’re doing here.  A lot of this has never been done before, at least in California.”

Despite the challenges for retailers, legal cannabis in California generated $832 million in excise tax revenue in 2021, more than double the $415 million from beverage alcohol sales. State excise tax on alcohol equates to $0.20 per gallon for beer and wine and $3.30 per gallon for liquor. Since alcohol is legal in all 50 states a federal excise tax also applies, which varies from $0.05 per can of beer up to $2.14 on a 750ml bottle of 80-proof liquor. Whether cannabis or alcohol, the costs for added excise taxes are usually passed on to the consumer.

Customers at West Hollywood’s dispensaries and consumption lounges pay 32% in taxes on top of the retail price of any recreational products they buy, which includes a 15% state excise tax, 9.5% state sales tax, and a 7.5% city sales tax. A $100 product purchase actually costs $132, “out the door.” For uninitiated consumers, the tax markup can be shocking or beyond their budget, especially in comparison to illegal cannabis products.  

“With the industry down and the price of cannabis taking a hit, it would be nice to see lower taxes,” Handal commented. “I mean, it’s one of the things keeping mom-and-pop shops like us out of the business. A lot of the smaller companies I’ve seen are struggling to weather the current rates and it’s becoming more difficult to compete with corporate giants moving into the space.”

Andrew DeAngelo, legal cannabis advocate and co-founder of Harborside, agreed with that assessment. While DeAngelo also is hopeful that the newly proposed legislation would eventually pass, he knows from experience that the bills are likely to be opposed by special interests or killed in committee before even coming close to being signed into law. If passed, the legislation is a step in the right direction, he said – but only a step in the marathon for survival. 

“There’s no place on earth that’s better suited for consumption than The Woods,” DeAngelo speculated. “But they can’t make any money. Because there’s no single serving of cannabis, like there is with a beer or a glass of wine, or a single service that you can charge and make money on, right? Every time you buy a glass of wine in a restaurant, the restaurant takes a good chunk of that money.” 

“This is a fundamental problem with not just consumption lounges, but pretty much the entire California supply chain. It’s not profitable. The regulations are not correct. The framework is not working so nobody can make money,” he surmised. “We live in a capitalist society. You have to be able to make money or the whole thing is gonna collapse, right? You could make the whole industry nonprofit, like Jerry Brown did during the medical [era] and that can work, too – but once you make it for-profit, then it has to be profitable.”

DeAngelo is somewhat stoic on how far – and more importantly, how fast – state legislators can go to enable growth for the industry. 

“I was part of the California Cannabis Industry Association for seven years, on the board of that organization. All we did was political work in Sacramento and we met everybody,” he described. “Some of these folks have authentically tried to help, but as soon as it came time for them to bleed a little bit and spend some political, real political capital on us, they ran for the hills. And they continue to. I don’t understand why they can’t reform [Proposition] 64? They have a super majority one-party rule in Sacramento. They should be able to fix this thing, but they don’t know how to fix it. They don’t want to admit that they don’t know how to fix it.”

The issues are systemic and can’t be solved with little fixes, DeAngelo said. 

“I would like to see the barriers to entry much lower and more equitable. But when you put handcuffs on entrepreneurs and you make these giant walls that they have to climb up while they’re handcuffed…ou know, it’s impossible.”

“I think if the frameworks allowed for more participation, lower barriers to entry, then we could start to get more people to come into the legal licensed market from the unlicensed market. Then the market overall gets bigger and it’s not fragmented. Both markets right now are hurting. Even though the sales are robust in the underground market, prices are dropping, supplies [are] high, and prices are low,” he added.

“It’s tough for everybody when at this particular moment in time there’s just too much weed in California, and we can’t get it out legally. A lot of it goes out illegally, of course, but that’s [addressed by] another bill that we got done last year – the Interstate Commerce Pacts.”

California Senate Bill 1326 was signed into law in September, and “creates a process for California to enter into agreements with other states to allow cannabis transactions with entities outside California.” Three legal states including California would first have to agree to form a pact, then develop regulatory standards and practices, as well as bureaucratic infrastructure, to facilitate interstate trade.

In 2019, Oregon Governor Kate Hill signed SB 582, the first law allowing interstate commerce regulation for cannabis. Currently, interstate commerce initiatives in Washington state (SB 5069) and New Jersey (SB 3012) have been introduced. 

While interstate commerce obviously would be a game-changer for legal cannabis businesses across the US, DeAngelo knows it will take more than legislative procedure to see significant action any time soon.

“You have to have at least three states to form a compact. So, once we have three states that have legalized a compact, then those three governors have to create a compact that’s legally binding and has rules for interstate commerce. Once those rules are established, assuming the industry complies with the rules, we can start engaging in interstate commerce legally.”

“The federal government may have a different interpretation,” DeAngelo warned. “There’s a real threat that the feds won’t like this and will do something about it. They would be technically violating the Controlled Substances Act – and politicians are very reluctant to do that.” 

One thing is certain – when eventually legalized at a federal level, the feds won’t waste any time slapping a national excise tax on cannabis products. Interstate trade would be likely to result in lower prices across the industry, with only a few deep-pocketed brands able to withstand the economic headwinds while attempting to scale up their multi-state operations.

But that’s on some far off horizon, maybe years further down the long road to even more regulations. How much longer can California industry members afford to lounge around until legislative actions and bureaucratic reform provide a path to profitability?

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